Problem Set Seven Solutions Chapter 9 1. Two car manufacturers, Saab and Volvo, have fixed costs of $1 billion and constant marginal costs of $10,000 per car. If Saab produces 50,000 cars per year and Volvo produces 200,000, calculate the average fixed cost and average total cost for each company. On the basis of these costs, which company’s market share should grow in relative terms? Answer : Average total cost is average fixed cost plus marginal cost: ATC = FC/Q + MC. Volvo’s average fixed cost $1 billion/200,000 = 5,000 is much less than Saab’s average fixed cost $1 billion/50,000 = 20,000 due to producing more cars. Volvo’s average production cost $15,000 is lower than Saab’s of $30,000 by the difference in average fixed costs. Volvo’s market share should grow relative to Saab’s. 6. What is the socially desirable price for a natural monopoly to charge? Why will a natural monopoly that attempts to charge the socially optimal price invariably suffer an economic loss? Answer
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